The present invention relates to a multi-tiered trading system and corresponding methods that allow multiple customers and multiple dealers to transact on a single platform while maintaining the distinction of a dealer system and a dealer-customer relationship.
Dealer-Customer Relationships
Dealers are defined as large financial institutions whose key objective is to deal in securities on behalf of their clients, both in the primary (new issue) and secondary markets. Customers of the dealers are typically large intuitional investors, including banks, hedge funds, mutual funds, corporations, and trusts. Dealers tend to be quite protective of their customer relationships because the dealer market is extremely competitive. To protect their client base, dealers have instituted a variety of trading systems that allow them to isolate their clients from and prevent their clients from establishing relationships with other dealers and/or service providers.
One way in which dealers attract customers is to invest capital in fixed income securities so as to provide liquidity within the marketplace for their customers trades. Dealers also frequently provide research services to their clients related to such securities products. Dealers often put their own capital at risk when buying and selling from clients by either (1) buying the securities first and warehousing them as inventory or (2) buying the securities and opening a new position in the market. Each of these approaches require dealers to use their own capital in order to provide liquidity to their clients. Dealers can therefore be considered market makers for their clients. While dealers prefer to buy and sell to their own clients, i.e., buying from one client to sell to another, if other clients are not prepared to trade, and the dealer is not willing to risk further capital, then the dealer will be required to utilize the open market to trade the client's securities.
How the Market Functions
Most people envision financial markets and trading systems in the context of the historical auction model used by the New York Stock Exchange (NYSE)—which operates a floor-based, open-outcry auction system with traders called specialists. While the auction model has historically been the dominant model, as technology has advanced, computerized systems have gained popularity among traders and customers. The NYSE, to some degree, has resisted computerization and continues to use the “open-outcry” auction system. Bids and offers for the stocks listed on the NYSE all go to a specific post on the floor of the NYSE. It is there that traders called specialists complete transactions.
However, other exchanges, like NASDAQ, operate electronically with a network of computers remotely connecting buyers and sellers. The NASDAQ operates an inter-dealer market represented by over 600 securities dealers trading more than 15,000 different issues. Dealers compete against each other to post the best bid and ask prices. Dealers can take customer orders either as a broker or as a dealer/principal. If the dealer acts as a broker, it arranges the trade between a buyer and seller, and receives a commission for its services. Alternatively, the dealer can act as a dealer/principal by either buying or selling from his own account, i.e., the dealer acts as a market maker.
The fixed income securities market is considered to be an over-the-counter market, i.e., a securities exchange where transactions are made via telephone or electronically rather than on a stock exchange. This means that there is no United States exchange for fixed income securities regulated by the U.S. Securities and Exchange Commission (SEC) or the Commodities Futures Trading Commission (CFTC), through which bids and offers are quoted and through which matched bids and offers are processed. Instead, regulation of over-the-counter markets is largely overseen by the National Association of Securities Dealers (NASD), a membership organization for securities-brokerage firms and underwriters in the over-the-counter market that sets guidelines for ethics and standardized practices.
The over-the-counter market is segmented into two tiers. The first is the dealer-customer market and the second is the inter-dealer or wholesale market. FIG. 1 provides an illustration of this prior art two-tier market structure. The dealer-customer market typically operates in three different manners: (1) direct relationships between the dealers A, C and C and the customers through use of each dealer's physical sales force (100); (2) direct relationships through the dealer A's electronic trading system (101), such as Credit Suisse First Boston's (“CSFB”) PRIMETrade system and Deutsche Bank AG's Autobahn system; and (3) indirect relationships through a third party multi-dealer system (102), such as Thomson Corporation's TradeWeb system and MarketAxess Holdings Inc.'s MarketAxess Corporate BondTicker product.
The inter-dealer system 104 enables dealers to match trades with other dealers. In order to protect the secrecy of their customers, inter-dealer brokers will market bids and offers for securities between the different dealers participating in the inter-market without disclosing the name of the potential buyers and sellers. The inter-dealer brokers market the offerings to other dealers either through telephone contact or through an electronic trading system that enables the brokers to post offerings on terminals that are connected via a communication network to the inter-dealer broker's computer system.
Inter-dealer electronic broker systems 104 provide liquidity between the dealers and offer full trading functionality. All dealers are treated equally and a dealer can both provide liquidity (make passive markets or bid/offer) and take liquidity (hit/lift a passive bid/offer). Examples of inter-dealer automated trading systems 104 include systems operated by BrokerTec USA, LLC, Garban Intercapital's ETC and eSpeed, Inc.
Current Electronic Trading Systems
The most common form of on-line trading is stock or equity trading. This type of trading pertains only to publicly traded securities, which are securities that are registered with the SEC. Currently, at least a dozen firms have on-line trading websites for publicly traded securities.
There currently are approximately thirty (30) electronic trading systems engaged in the on-line sale and/or trading of one or more types of treasury, municipal and corporate bonds. These systems can be broken down into: (1) dealer systems that allow users to trade only with dealers, but not with each other; (2) cross-matching systems that allow users to trade with each other anonymously; (3) primary market bidding systems that allow users to bid directly on new issues; and (4) a direct issuance system that allows investors to buy securities directly from the issuer.
Limited information is available regarding the operation of most of these systems, as access is limited to authorized users. For example, CSFB's PRIMETrade system is only available to registered CSFB clients who have agreed to and signed the PRIMETrade Access Agreement. CSFB publicly describes the PRIMETrade system, which is a dealer system, as a network based trading platform that provides its customers with electronic access to Listed Derivatives; Cash Equities; European Government Bonds & Eurobonds; U.S. Treasury Bonds & Agencies; Emerging Markets Bonds; Australian and Japanese Government Bonds; and global Foreign Exchange products.
Similarly, the multi-dealer TradeWeb system is publicly described as a dealer-to-customer platform that provides liquidity for fixed-income products. The system provides a platform for trade between many of the world's primary dealers and buyside institutions. At present, the TradeWeb system provides executable prices from multiple dealers and markets in real time for ten products: U.S. Treasuries, U.S. Agencies, Commercial Paper, European Government Bonds, TBA-MBS, Pfandbriefe/Covered Bonds, Euro Supranationals/Agencies, Agency Discount Notes, ECP and Corporates. Hence, the TradeWeb system, which is effectively an auction model, enables institutional investors to receive live price quotes simultaneously from designated dealers and to trade instantly.
Inter-dealer electronic broker systems play an important role in providing liquidity between the dealers while also facilitating full trading functionality. An example of an inter-dealer electronic trading system is the exchange offered by BrokerTec.
BrokerTec provides its users with access to a deep pool of liquidity that includes major participants in both the U.S. and European fixed income marketplaces. BrokerTec remains neutral on all trades while keeping the identities of all its participants confidential, thereby providing users a platform for anonymous price discovery and trade execution. This anonymity allows customers to trade without revealing either their strategy or identity to the marketplace. Once registered with BrokerTec, dealers gain access to BrokerTec's system through a customizable front-end screen. Operating through this screen, dealers are provided with fast navigation and real-time trade execution capabilities.
The systems described only focus on supporting one tier of the market structure, and as a result, create disadvantageous for both customers and dealers. Dealers prefer to use affiliated electronic systems so that they can may maintain the exclusive nature of the customer-dealer relationship. Customers, however, are disadvantaged by such singular systems as they lack liquidity, or sufficient liquidity for many customers, so customers must use multiple dealer systems in order to have access to the best liquidity from a plurality of dealers. Customers and dealers will both need to see an advantage from using an electronic system for dealers to adopt such a service.
The introduction of multi-dealer systems has offered a partial solution for providing customer liquidity. The systems allow a customer to link to more than one dealer on the same platform. In these systems the dealer is still the market maker and the customer is still a price taker. That is to say the customer asks multiple dealers at the same time to make a price (buy or sell) a particular security for a specified size. The customer then can trade the best price efficiently.
Inter-dealer systems are exchange like and have grown to have enormous liquidity. These systems have become so important to the dealers in off-setting transactions and determining market pricing that customers have begun to request access to these marketplaces. Dealers, however, are reluctant to grant customers access to the inter-dealer markets for fear of losing customers to competing dealers. Thus, the industry is presently faced with the challenge of allowing customers access to inter-dealer systems while keeping customer-dealer relationships intact.